[based on Geiger, 2006: 8-27; and Geiger, 2008: 4-18]
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Instruments with ratios, e.g. reserve requirements,
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Instruments with interest rates, e.g. central bank lending rates,
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Quantitative instruments, e.g. open market operations, and
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Other instruments, e.g. central bank bills.
The classification used in this work somewhat differs from the four categories.
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Two main categories of central bank instruments are distinguished: Price-based and quantity-based instruments.
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All four above-mentioned categories are subsumed under the category of price-based instruments. Certainly, open market operations (OMO) are originally designed to control the monetary base and therefore can be counted as a quantity-based instrument. But, in a market based financial system, every amount of monetary base has its corresponding price. Thus, the major central banks in the world use OMOs to control the money market rate rather than the monetary base. The PBC is no exception to this. For instance, the PBC carried out 24 repurchase operations (“repos”) in 2001 ( 2 ). In 19 operations quantity tenders with a fixed interest rate were used. In the same year, in 26 reverse repos, solely quantity tenders with fixed interest rates were operated ( 3 ).
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Quantity-based instruments are those instruments that are non-market conform, i.e. instruments that change the amount of money in the financial system without taking into account the price of money. Instruments that would fall into this category are the nowadays-abolished credit plan or newly introduced instruments like window guidance. Capital controls also can be counted to this category since controls leverage on the quantity of capital and not on its price.
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Additionally, price and wage controls as non-central bank instruments have to be considered. Non-central bank instruments influence the final targets ( 4 ) of the monetary policy in China without being primarily monetary policy instruments. For a full analysis of this influence, please refer to Geiger, 2008.
1 Instruments of the People’s Bank of China as the central bank of China
1.1 Price-based indirect instruments
Monetary policy textbooks describe the transmission of monetary impulses, among others, via the interest rate channel of monetary policy transmission (cf. Bofinger, 2001). In a very simplified description the interest rate channel can be described as follows: In the case of a too expansionary monetary stance the monetary authorities would increase their primary lending rate. In a completely market-based environment the stance of the lending rate will be displayed in the inter-bank money market and via the expectations channel transformed into all different maturities. Thus, the commercial banks’ refinancing costs will increase due to the increase in the primary lending rate. The higher costs of financing for the commercial banks will lead to higher interest rates for outflowing credits to third parties. Higher interest rates in turn will lead to less demand for credits from the non-banking sector and thus lead to a slowing of the real sector. The reverse logic would apply for the situation of a too restrictive monetary stance. The interest rate instrument influences final targets via its interaction with intermediate targets.
In China the interest rate channel of monetary transmission is blurred. Due to the partially interest rate liberalization, price-based instruments in China have two different underlying mechanisms of action. First, there are instruments that transform the central bank’s policy stance via the interest rate channel of monetary transmission, e.g. OMOs or minimum requirements. Second, there are instruments that are not yet subject of full liberalization and thus act under the disguise of price-based instruments, e.g. PBC lending and deposit rates. This means that there are two different ways of transmission of interest rate changes: a) The transmission of interest rate changes according to the (simplified) textbook interest rate channel where a interest rate change of the PBC triggers a change in refinancing costs of commercial banks and thus changes the interest rates charged by the commercial banks to 3rd parties; and b) the transmission of interest rate changes as result of administered interest rate changes where commercial banks have to change the interest rate for money that is already at their disposal and thus result in changes of commercial bank’s interest rates to 3rd parties.
1.1.1 PBC lending and deposit rates
Xie (2004a) tries to show that the PBC lending and deposit rates work in a similar market-oriented way as facilities of Western central banks such as in the case of the European Central Bank (ECB), where the marginal refinancing and the deposit facility constitute the upper and lower limit of the money market interest rates ( 5 ). Accordingly Xie argues that the PBC lending rate had constituted the upper limit of the money market rate since 1998 and that the lower limit of the money market from 1998 to 2002 was defined by the interest rate on required and excess reserves (Xie, 2004a: 20) ( 6 ). In theory, this is correct. But while there had certainly been progress towards a price-theoretic underpinning of monetary operations since the mid-1990s, the situation described by Xie (2004a) does not cover the whole financial system. In certain circumstances the PBC lending and deposit rates have to be seen as an administrative order from the monetary authority that leverages on existing money already at the disposal of the commercial banks. Thus, credits to non-bank third parties are not necessarily based on a utility-calculation in terms of costs for refinancing from the PBC (the same logic applies for deposits respectively) ( 7 ).
The PBC administers two different benchmark interest rates, the benchmark lending rate, which is the one-year PBC lending rate and the benchmark rate of central bank lending that is the rediscount rate ( 8 ). The PBC lending rate gives the commercial banks a certain degree in setting their interest rates according to their assessment. At the beginning of 2004 the upper limit of the lending rate for commercial banks and urban credit cooperatives was set to 170 per cent of the PBC benchmark rate and the ceiling for rural credit cooperatives at 200 per cent respectively. The lower limit of the lending rate for all financial institutions was installed at 90 per cent of the PBC’s benchmark rate. In October 2004, the ceiling for commercial banks and urban credit cooperatives was abolished and the cap for rural credit cooperatives increased to 230 per cent. The lower limit for all financial institutions remained unchanged (PBC, 2004g). While these and other liberalizations indicate progress towards market-determined interest rates ( 9 ), controlled interest rates are still a reality. For instance the PBC still steers the deposit rates that commercial banks can grant to customers. This results in a particular problem, since the central bank has to make sure that the commercial banks have access to funds at rates below the deposit rates to ensure profitability of the commercial banks (CB) within the Chinese financial system (Xie, 2004a).
To adjust the benchmark lending rate the PBC needs the consent of the State Council. Through this dependency on the State Council the “central bank lending rate is still not flexible to meet the needs called for by the pre-emptive or fine tuning of monetary policy” (PBC 2005c: 19). Moreover, the insufficient instrument independence of the PBC is the cause that monetary policy in China often fails to react timely to changes in the monetary policy environment. To mitigate this negative effect, since 25 March 2004, the PBC is allowed to add a surcharge on its central bank lending rate at its own discretion (PBC 2005c). The development of the PBC lending rate and the deposit rate in relation to the inflation rate are displayed in figure 1 from 1987 to 2006.
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Figure 1: Development of the lending and deposit rates in China, 1987 to 2006
In fact, the development of the PBC lending rate in 2006 points to an enhanced ability to fine-tune the instrument from the side of the PBC. In that year two slight increases of the PBC lending rates followed each other very shortly: The first one on 28 April 2006 by 0.27 percentage points and the second one on 19 August 2006 by 0.27 percentage points again up to 6.12 per cent. On the second occasion the deposit rate was also increased by 0.27 percentage points to 2.52 per cent.
1.1.2 Discount and rediscount rate
Before 1998 the discount and rediscount rates were set within a floating range of 5 per cent to 10 per cent below the commercial banks’ loan and PBC lending rates respectively. Since 1998, the rediscount rate was determined in line with other central bank lending rates. In 2004, the rediscount rate was installed as the benchmark rate of central bank lending, i.e. the PBC was given the possibility to change central bank lending rates within a floating range around the rediscount rate without prior approval of the State Council. However, the turnover of operations within the rediscount instrument itself is too small to have some significant influence on the growth of monetary base. Thus, today the rediscount policy primarily aims at influencing the commercial paper market (PBC, 2004e; PBC, 2004f; and Xie, 2004a: 3ff.).
1.1.3 Reserve requirements
The PBC introduced minimum reserve requirements in the year 1984 in order to control the financial sectors liquidity. At first, the officials set different reserve obligations for the different deposits with regard to their origin and the institution actually holding the reserves ( 10 ). In 1985 the PBC combined all different reserve requirements and set one minimum reserve requirement at 10 per cent. But only from 1998 on the instrument of the reserve requirement was more actively used (table 1) ( 11 ). That year also marks the time when the PBC shifted its monetary policy from direct control to more indirect control and made open market operations (OMO) the main instrument of its monetary policy. The Chinese reserve requirement regime has three particular features:
First, minimum and excess reserves are interest bearing. According to Schlotthauer (2003), during the 1990s the interest paid on the reserves was so high that there were years in which the dominant strategy of a commercial bank was to hold reserves at the central bank instead of granting a risky loan to an enterprise (Schlotthauer, 2003: 212). However, the PBC argues in favor of the interest-bearing component that by this it was able to constitute a lower limit for the money market rate (Xie, 2004a: 20). This, however, could not be constantly achieved (PBC, 2000).
Second, the financial system holds high ratios of excess reserves, as showed above. Interestingly, rural credit cooperatives (RCCs) hold the highest ratios of excess reserves amongst all financial institutions in recent years (PBC, 2004a: 6). And RCCs are subject to credits in the direct central bank lending scheme as they are subsidized with central bank money at a very low lending rate. Thus, the example of the RCCs shows clearly that the administered command style PBC lending rates blur the price-theoretic interest rate channel of the Chinese financial system.
And third, in April 2004 the PBC decided to formally introduce a policy of “differentiated required reserve ratio for different financial institutions” (PBC, 2004b), which linked the required reserve ratio applicable to financial performance indicators such as capital adequacy ratio and asset quality as well as geographic and institutional scope of the organization, i.e. rural and urban credit cooperatives (PBC, 2003c). Thus, in 2004 financial institutions with capital adequacy ratio below the 8 per cent threshold of the Basel Accord were subject to an 8 per cent required reserve ratio, while ratios for rural and urban credit cooperatives were frozen on the 1999 level of 6 per cent (PBC, 2004c; and PBC, 2004d). This decision, however, largely seems to be an one-off event: Since then reserve requirement ratios for financial institutions subject to the differentiated regime as well as the urban credit cooperatives were adjusted with the same stance as the general reserve requirement ratio ( 12 ) (PBC, 2006a; PBC, 2006b), implying that by the end of 2006 the reserve ratio for financial institutions with insufficient capital adequacy was 0.5 per cent higher and for urban credit cooperatives 1.5 per cent lower than for all other institutions. By end 2006, rural credit cooperatives were still subject to the 1999 ratio of 6 per cent.
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Table 1: Reserve requirement ratios in China, 1985-2006
Table 1 shows the development of the reserve requirement in detail between 1985 and 2006. The table illustrates the mentioned passivity in using the instrument between 1985 and 1998 and the ever-increasing activity since 2003 with 5 upward adjustments of the general rate in the three years between 2003 and 2006. The justifications of the PBC in regard to these adjustments show that the reserve requirement ratio is more and more seen as a main instrument to control liquidity in the financial system at large and restrain the relatively fast growth of monetary and credit aggregates of the economy between 2003 and 2006 (PBC, 2003c; PBC, 2006a; PBC, 2006c; PBC China Monetary Policy Reports, various issues). To this end the requirement to hold reserves with the PBC is one means to offset the effects of ever rising capital inflows into China. Through the frequent adjustments, three of them in 2006, it was made clear that the instrument of reserve requirement is a major component of the current monetary policy toolbox of the PBC.
1.1.4 Open market operations (OMO)
In 1993, the PBC introduced the instrument of open market operations (OMO) into its monetary policy toolbox. But the authorities soon had to realize that the institutional foundation with the absence of an inter-bank market and only rudimentarily liberalized interest rates was not strong enough to establish well functioning OMOs. Thus, in the following years only few OMOs were carried out and on a very low scale. Therefore, the central bank decided to suspend OMOs in the year 1997 ( 13 ).
On May 26, 1998 the authorities officially re-introduced OMOs ( 14 ). Under new circumstances with a better institutional foundation, the operations were an immediate success. Ever since, OMOs have represented a key instrument for the conduct of monetary policy in China. Before 27 February 2003 open market operations were generally carried out once a week – on Tuesday. Between February 2003 and May 2004 several adjustments to the Frequency have been made on trial basis with the occasional introduction of a second trading day – the Thursday, particularly between February and April 2003. This was a move to promote and support the institutional foundation for open market operations in China (PBC 2003d). Since 11 May 2004 open market operations have generally been conducted on two days per week – Tuesday and Thursday.
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From May 1998 to mid-2000 only repurchasing operations were utilized for the sole purpose of issuing base money. Since mid-2000, however, a major shift took place: Repurchase agreements were increasingly used to withdraw base money from the financial system (table 2). This became necessary as increasing amounts of foreign exchange had to be purchased with RMB to keep the de facto peg of the exchange rate (cf. box below). Through the purchase of foreign exchange (“foreign exchange interventions”) the amount of RMB base money increased. To compensate (“sterilize”) for foreign exchange interventions, repurchase operations are one effective tool that can be applied. However, since there is a limit to the potential to sterilize through pure repurchasing operations, in 2003, the central bank started to additionally issue central bank bills (table 2) ( 15 ).
While “reverse repos” made up the majority of operations up to 2002, starting from 2003 the usage of OMO for the issuing of monetary base became insignificant (table 2). In fact, the usage of “repos” and the issuance of central banks increased dramatically over time, with a peak in 2005, reflecting the ever-increasing need for sterilization of foreign exchange interventions between 2003 and 2006 (cf. box 2). In 2006, only one “reverse repo” took place, compared to 39 “repos” and 97 central bank bills (table 2).
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Box : Sterilization of foreign exchange inflows
Sterilization measures are those operations that are able to keep the money market under control through offsetting the expansion of monetary base caused by foreign currency inflows with compensating measures. The problem of sterilization operations is that they cause costs. These sterilization costs are defined through the domestic and foreign interest rate differential. Domestically, on the one hand, the central bank has to offer a certain interest rate to absorb the excess liquidity. On the other hand, the central bank earns money on its acquired foreign exchange reserves. “Thus, if a central bank tries to target a constant nominal [original italics] exchange rate (…) in a situation where the domestic interest rate is higher than the foreign rate, it is not able to defend its currency against strong appreciation pressure for long” (Bofinger, 2001: 390).
There are currently two main opinions vis-à-vis the cost of sterilizing foreign exchange rate in China: The proponents of the argument that the exchange rate regime is one major cause of the uncontrollability of the development of monetary base in China usually argue that the costs (direct and indirect) of sterilization are too high to be maintained over an extended period (Goldstein, 2004: 27; and Goldstein et al., 2007: 7f) ( 16 ).
The other group argues, correctly in my view, that sterilization measures up to 2006 were always able to compensate all capital inflows into China, including those induced by the foreign exchange regime. As a result, the impact of capital inflows on the domestic liquidity conditions was virtually insignificant (Anderson, 2006; and Anderson, 2007). Moreover, several studies come to the conclusion that the sterilization costs in China are either very low or even negative, i.e. the PBC is likely to make money through the exchange rate regime (cf. Anderson, 2005; Anderson 2006; Green, 2005; and Qu, 2005). For instance, Green (2005) calculates that the PBC received a net income of the exchange rate peg in 2004 of “at least (…) USD8.4bn (…) and possibly as much as USD 15.4bn” (Green, 2005: 25) ( 17 ).
Two main reasons can be put forward: First, low domestic interest rates vis-à-vis foreign interest rates. While this effect started to fade with the recent increases in domestic interest rates, still, as Anderson (2007) puts it: “Short-term money market rates are not aggressively above US levels”. Second and more important, extraordinary stocks of foreign exchange reserves. It is crucial for the computation of the costs to compare the interest rate expenses of the outstanding debts for sterilization purposes with the whole stock of foreign exchange reserves. As Anderson (2005) put it for 2005, one has to compare interest payments for around USD 200 billion domestically with interest gains for around USD 700 billion. In this situation, the lack of the exact knowledge of the interest rate returns matters far less than Goldstein (2004) argues. The sheer size of the dollar stocks indicates that there is a profit, and the stock of USD rose up to USD 1,068 billion by the end of 2006.
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1.2 Quantity-based direct instruments
Before the reform era, the credit plan acted as the financial framework for the state investment plan. Necessary credits to reach the given output targets have been summed-up. Since the 1980s, the instrument of the credit plan has been adjusted several times according to the new financial and economical environment. In 1996, still, the credit plan was the most important monetary policy instrument of the PBC (Mehran et al., 1996a: 41f.). Only in 1998, when the credit plan was officially abolished and OMOs were established, the latter became the main monetary policy instrument in the PBC’s toolbox.
Today preferential lending to certain areas and industries is still observable. Thus credit allocation in those areas does not follow cost-utility criteria, i.e. credit allocation is not steered by the price but by the required and/or desired amount of money. In a nutshell, there still is a quasi credit plan in effect. However, compared to the long-term determination of the official credit plan(s) of former times, the amount-driven credit allocation of today serves on an adhoc basis. The two instruments of window guidance and direct PBC lending are mainly used for the quantity-based allocation of credits in the Chinese financial system.
Additionally, there is a third instrument within the quantity-based instrument toolbox of the central bank, the capital controls. Please refer to Geiger, 2008, for more details.
1.2.1 Window guidance
The PBC started to adopt the policy of “window guidance” ( 18 ) in 1998.The framework for the Chinese window guidance was closely modeled according to the Japanese system, which had been in place for more than 40 years until its suspension in the early 1990s. This policy uses benevolent compulsion to persuade banks and other financial institutions to stick to official guidelines. Central banks put moral pressure on financial players to make them operate consistently with national needs (N.A., 2004). A major point of the concept is the temptation to influence the market participants through words rather than strict rules. Despite the phrase guidance, which implies a voluntary aspect in the system, the PBC has a major influence on the lending decisions especially of the four state-owned commercial banks (Ikeya, 2002: 2ff.).
The PBC regards the instrument “as an important monetary policy instrument [that] can be combined with other instruments to guide market expectations”. Through “making the market anticipate its monetary policy” the PBC claims to achieve a more effective overall monetary policy (PBC 2006g: 16).
On June 5, 2003, the PBC initiated a particular window guidance process to curb the expansionary tendency in the economic cycle 2003/04. This process was started with publishing a notice about “Further Strengthening the Management of Real Estate Credit Business” and targeted at certain and especially the real estate sector. Following that, the PBC asked for window guidance meetings three times in the second half of 2003. In those meetings on July 18, August 11 and September 12 the PBC invited representatives of all Chinese financial institutions and repeatedly asked them to pay attention to the proper capital adequacy ratio and to prevent credit and liquidity risks. Facing a very fast growth of commercial bank loans to the real estate sector at that time, “the PBC timely signaled risks on real estate loans in June to further standardize its development and strengthened window guidance on commercial bank loans” (PBC, 2004a: 2). This was a rather strong urge to calm down the commercial banks lending for real estate businesses.
Since the beginning of 2004, monthly assessments of the PBC “to review economic and financial development and strengthen warnings for the commercial banks to guard against potential risks” (PBC, 2004h) have been added to the window guidance policy. In monthly meetings credit guidance and information about risks were provided to the commercial banks as an outcome of the assessments (PBC, 2004i). Additionally in 2004, a large-scale window guidance meeting with all commercial banks took place on March 23, 2004, with the target to set up a credit restriction mechanism according to the commercial banks’ risk-control abilities and their capital adequacy (PBC, 2004h).
In 2005, besides the continuation of monthly assessments, one major window guidance conference was convened on 21 January (PBC 2005 d; and PBC 2006d). In the conference representatives of the state-owned commercial banks, joint-stock commercial banks, policy banks, and the PBC branch offices gathered with a particular focus on “credit support to the rural economy and the non-state sector”, since they play “a very important role in promoting the coordinated development of the national economy” (PBC 2005d). Additionally the role of innovation within the financial institutions and improved financial services for agricultural loans were discussed.
Since April 2006 a significant strengthening of window guidance has been recognizable mainly due to the pertinent high growth of the economy throughout the year (PBC 2006e). Six meetings were scheduled on 27 April, 18 May, 13 June, 15 August, 3 November and 8 December. All meetings came shortly after respective meetings by the State Council called for prudent macroeconomic policies to reign excessive loan growth. In the meetings financial institutions’ representatives were “urged (…) to comprehensively, correctly, and actively implement the macroeconomic management policies formulated by the central government” (PBC 2007a), a rather strong call to adhere to official guidelines. The meetings showed a mix of dampening efforts “to industries with excessive investment” as well as diversification with financial innovation and again through a special focus on rural areas and the non-state sector (PBC 2006e; PBC 2006f; and PBC 2006g).
The reasons for window guidance being relatively successful in China is to a great extent in the fact that the governor of the PBC is a higher-ranking official than the leaders of the commercial banks. Thus, according to the hierarchical system the commercial bank leaders have to adhere to orders made within the policy of window guidance.
1.2.2 Direct PBC lending
Direct PBC lending as a monetary instrument is in the legacy of the planned economy, the usage of which was officially discontinued in 1994 (Mehran et al., 1996b: 19). However, the last decade or so was marked with a high amount of central bank money permanently being in the financial system, evidenced for instance by excess reserve ratios well above the 10 per cent margin in the 1990s, which only gradually came down to 7.61 per cent in 2001 and 5.38 per cent at the end of 2003. In 2005 and 2006 excess reserve holding stabilized between 4 and 5 per cent (PBC China Monetary Policy Reports, various issues; and Cheng et al., 1996). This relatively high amount of central bank money to a great extent is caused through long-term central bank loans that are subject to low interest rates without being linked to the predominant monetary policy stance.
The long-term loans can be seen as a “planned economy-style” fixed-quantity contribution from the central bank to the commercial banks. Direct central bank lending appears to be the main source of such provision of central bank money. The total amount of outstanding central bank lending was over 200 billion USD in 2002, which was about 9 per cent of the monetary aggregate M2 (Xie, 2004a: 20f.). Today’s central bank lending appears in very different ways: As indirect subsidy for rural credit co-operatives with very low lending rates to those institutions and as “lender of last resort” to bail-out financial institutions as well as lender to local governments, asset management companies and rural credit co-operatives to get rid of NPLs.
2 Non-central bank policy instruments
2.1 Price controls
Since 1998, three kinds of prices have been predominant in China (N.A., 1998a; and WTO, 2001):
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Market-regulated prices, which are set by the market through supply and demand and are not faced with any intervention from authorities.
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Government guidance prices, which can come either as a benchmark price or a floating range set by the government. The floating band is usually between 5 and 15 per cent.
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Government prices, which are fixed prices set by the responsible government authorities and are unchangeable unless the approval of this authority.
There are prices that have to be set by the central government and other prices that can be set and controlled by the province, the autonomous region or the municipality level. They can be set either by the relevant price department or other related departments. Basis for the control is the listing on so called price catalogues, which can be issued by both central and local governments ( 19 ). Centrally controlled prices need the approval of the State Council and prices for the local catalogues need the approval of the government of the applicable level ( 20 ). Governments below the province, autonomous region or municipality level cannot issue own price controls. Goods, public utilities and services are only eligible when they fall in one of the categories of the following table (table 3).
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Table 3: Criteria for government control of prices
The report of the working party on the accession of China into the World Trade Organization (WTO) of October 1, 2001, defined the scope of price controls allowed to be in place in China after the WTO entry. The report lists all products, public utilities and services, which are subject to price controls according the classifications of government pricing and government guidance pricing. The report emphasizes that controls “shall not be extended to goods or services beyond those listed (…) and China shall make best efforts to reduce or eliminate these controls” (WTO, 2001: 77ff.).
As the eligible criteria show, one strong motive in favor of the introduction of price controls is the securitization of the provision of goods and services of national importance ( 21 ). Additionally, the management of the general price level clearly is a motivation of price controls. Article 26 of the Price Law of the People’s Republic of China, which fits into the chapter “Control and Adjustment to General Price Level”, states: “To stabilize the general price level is one of the major objectives of macro-economic policy.” Without directly referring to price controls the law leaves no doubt that price controls are seen as one measurement of macro-economic policy to influence the general price level. And there is evidence of the government’s active usage of the tool of price controls even in the post-WTO era. The recent threat of an overheating economy with growing inflation rates prompted the authorities to employ price-controlling measures more frequently again, for instance:
- The National Reform and Development Commission (NRDC) in China instructed the provincial authorities in March 2004 to freeze any approval for price increases for the next quarter of the year. The freeze applies if either the m-o-m local CPI growth reaches 1 per cent or higher or y-o-y monthly local CPI reaches 4 per cent or higher for three consecutive months (Wu, 2004b).
- Using a more indirect measure, the NDRC also asked local governments to set ceilings for profit rates for fertilizer wholesales, e.g. three per cent in Heilongjiang and two per cent in Hunan Province. Additionally, a 50 per cent rebate on VAT in the fertilizer industry was re-introduced. The move is aimed at raising the output of crop and thus to reduce the inflationary prices in the food sector (cf. People’s Daily, 2004a; and Tan, 2004).
The recent development reminds of the call for more effective price controls during the high inflation period of 1993/94. In June 1995 the China Daily published an article with the title “Strong measures need to guide pricing system” (Fu, 1995). The article quotes a research fellow of a research centre of the State Council who pointed that the lack of price controls in the market economy had a strong influence to the increasing inflation during that time. This was the beginning of a discussion that ended with the introduction of the Price Law of the People’s Republic of China in 1998.
There are no signs that the authorities want to turn back the time and re-introduce controls beyond the Price Law and the WTO agreement. However, it is evident that the authorities use their discretion in setting price controls more actively in times of inflationary or deflationary pressure. In 1998, for instance, the first year of the deflationary period of the late 1990s the authorities used the instrument and set minimum prices in 21 industries to ease the deflationary pressure (Roberts, 1998). However, the results were moderate; the deflationary environment lasted for four years indicating limitations of the instrument of price controls.
2.2 Wage controls
Historically, in 1978, China’s wage regime was characterized by a centrally regulated salary system that, among other things determined the wages according to regions, occupations, industries and sectors. The heart of the system was a classification scheme with more than 300 standardized occupational classifications used for the salary formation. After 1978 the wage regime had undergone three sets of reforms in 1985, 1992 and 1994/95, respectively (Yueh, 2004). The two reforms in 1985 and 1992 incorporated an indexation of wages to the development of the consumer price index. Thus, high inflation had an impact on the wage level setting; and higher wages, in turn, triggered higher inflation rates. This constituted circles that easily led to an inflationary spiral via ever increasing inflationary expectations ( 22 ).
In 1994/95, the authorities decided to undergo a wage reform that uncoupled the wage setting from the inflation rate and thus attempted to burst the circle of accelerating inflation expectations during the high inflation period of the early 1990s. The reform can be divided into a stricter rules-based (1994/95 I) and a more blurred recommendation-based part (1994/95 II) ( 23 ). Companies eligible to set their wages according to the rules-based component could use their discretion within the framework of two standards: First, the growth rate of the total salaries of an enterprise had to be below the growth rate of after-tax profitability. Second, the growth rate of per-capita wages ought to be less than the growth rate of labor productivity. Within the second, the recommendation-based part of the reform the “MOL [Ministry of Labor (by MG)] suggested to enterprises that wages are set not only according to occupation and rank, but also based on skills and productivity” (Yueh, 2004: 153).
Eligible companies for the 1994/95 I reform are those companies that are publicly listed on the Shanghai or Shenzhen stock exchange. There was no distinction made between private and state ownership. However, it can be argued that private companies would welcome any productivity related discretion in their wage setting and therefore start to set their wages according to the reform scheme. As will be shown later, a great part of the publicly listed companies were and still are subject to state control. Thus, the impact of the reform scheme heavily depends on the state’s capability in enforcing its’ rules.
Companies eligible for the 1994/95 II reforms are those SOEs that underwent a partly ownership-transformation without being listed on the stock exchange (Yueh, 2004). It will be argued that the number of companies and their employees falling under the 1994/95 II wage scheme is much higher than it is in the case of the 1994/95 I reform.
The two reform approaches differ fundamentally in terms of the content as well as the scope of companies eligible. The second part of the reform represents a guideline, which enterprises are suggested to follow rather than it stands for a strict rule. Geiger (2006) estimated the number of employees that fell under the 1994/95 reforms and the share of total wages that could be affected (Geiger, 2006: 22-27). He found that 12-15 per cent of the Chinese wage bill could potentially be influenced in 1995 and around 14 per cent in 2001.
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Footnotes
( 1 ) Xie mentioned that the PBC had introduced and tested 14 monetary policy instruments since 1983.
( 2 ) According to own calculations, based on data published on www.chinabond.com.cn.
( 3 ) The ratio of fixed interest rate tenders diminished in recent years due to the emergence of central bank bills to sterilize exchange rate inflows. To sterilize certain amounts of money the focus is on the quantity rather than on the interest rates. Still, the interest rate on the money market showed a rather stable course.
( 4 ) The notion of “final targets” in this work refers to the three final targets of Chinese monetary policy as identified by Geiger (2006): Inflation rate, GDP growth rate, and exchange rate (Geiger, 2006: 7).
( 5 ) In the case of the ECB commercial banks can use the ECB facilities, the marginal refinancing facility and the deposit facility to finance their short-term liquidity (Bofinger, 2001). They can also use funds from the money market to balance their positions. All credit businesses to non-bank third parties have to be backed-up by central bank money. If the operations expire the commercial banks will have to get new funds via the central bank or the money market. Through the interconnection to the money market, the marginal refinancing and the deposit facility constitute the upper and lower limit of the money market interest rates. Eventually, according to the interest rate channel of monetary transmission the levels of the ECB’s facilities influence the rates of lending businesses between commercial banks and non-bank third parties.
( 6 ) In fact, however, the money market rate was constantly below the interest rates on reserves for the time from 1996 to 1999.
( 7 ) The add-on problem that huge parts of credits are not negotiated according to project risks is not subject of this analysis.
( 8 ) Please refer to the next section of this chapter for details.
( 9 ) Since the start of “market-based interest rate reform” in 1993 a series of interest rates were liberalized, such as: Interest rates in the inter-bank markets; the issuing rate of treasury bonds and policy financial bonds; the interest rate on foreign currency loans and large-value foreign currency deposits; interest rates on long-term large-value RMB negotiated deposits; and generally the band of interest rates of loans in RMB was gradually widened (PBC 2005c).
( 10 ) For instance, the Agricultural Bank of China (ABC), the Industrial and Commercial Bank of China (ICBC), and the Bank of China (BOC) had to hold 20 per cent on deposits of companies, as well as 40 per cent on money of urban and 25 per cent of rural origin. The China Construction Bank (CCB) had a requirement of 30 per cent regardless of the money’s origin.
( 11 ) Excess reserves can be voluntarily held only since 1998.
( 12 ) The general reserve requirement ratio applies to: The “Big Four” (ABC, BOC, CCB, and ICBC), joint-stock commercial banks, city commercial banks, rural commercial banks (rural cooperative banks), China Agricultural Development Bank (a policy bank), trust and investment companies, finance companies, financial leasing companies and relevant foreign funded financial institutions.
( 13 ) Please refer to Mehran et al. for a detailed description for the early years of OMOs (Mehran et al., 1996a: 47).
( 14 ) Please refer to Dai, who delivers a detailed explanation of the conduct of OMOs in China (Dai, 2003: 57).
( 15 ) The PBC publishes – on each trading day – the results of the very day. The information is announced via two web pages, the “China Bond Market Information Network -中国债券信息网” (www.chinabond.com.cn) and the “China Money Network – 中国货币网” (www.chinamoney.com.cn). Both sites are closely connected to and at least partly operated by the PBC or one of its departments.
( 16 ) Yu Yongding, Professor at the Chinese Academy of Social Sciences and as a member of the Monetary Policy Committee at the PBC argues in a similar way: According to an article of the Financial Times from April 14, 2005 he “thinks sterilization can continue for ‘quite a while’ but says the cost is getting higher” (Balls et al., 2005).
( 17 ) This assessment was confirmed for the subsequent period of 2005/06 through two new studies by Green as referred to by Goldstein et al. (2007).
( 18 ) This is the translation of the Japanese expression. It is also known as “moral suasion” and “jawboning”.
( 19 ) According to the WTO Report of the Working Party on the Accession of China, the authorities are obliged to publish these catalogues in the Pricing Monthly of the People’s Bank of China, which is partly available in the Internet via www.hebwj.gov.cn.
( 20 ) In fact it is not possible to distinguish the different price catalogues and show clearly which prices are subject to central or local control. Local governments have to inform the central government about their decision of controls, which then incorporate the prices in its catalogue. In turn, local price catalogues contain centrally administered prices, too. Thus, the central and local governments’ price catalogues are fairly similar.
( 21 ) It is arguable if price controls can pursue such a target at all. Please refer to Rockoff’s “Price Controls” at www.econlib.org/ for a detailed discussion.
( 22 ) For a detailed discussion of the development of the inflation rate in China for the period of 1978 to 1995 please refer to Imai (1997).
( 23 ) It is important to point that the issues to be discussed in the 1994/95 reform analysis relate primarily to the wage settings in state-owned or partly state-owned units in the industry sector. Therefore any effects of the reforms are decreasing with a declining importance of state-owned enterprises in the Chinese economy. For instance, from 1991 to 2001, the employment in the state-owned industrial sector declined sharply from 44.7 million to 18.2 million people, whereas employment in the non-state-owned sector increased sharply from 1.82 million to 15.5 million people (National Bureau of Statistics of China, China Statistical Yearbook, several issues).
Another obstacle in the calculation of wage control effects is the definition of “employment” in the context of state owned enterprises. In 1998 around 8.8 million workers of the 15.7 million workers who have been laid-off within the state-owned sector have been subject to “xiagang”, i.e. affected employees are still registered at their work unit but do not go to work and do not receive any wages.
